New-car prices: How used cars play their part

Automakers look at older cars when pricing new ones

It’s a pretty special moment: the day a driver gets the keys to a brand-new vehicle. But most people find there’s another day when that shiny new car gets too old, or no longer fills a need, and it goes back on sale as a used car.

You might think its role in the new-car market ends the day it’s driven off the dealer’s lot. In reality, each vehicle sold is still in play, and it’s affecting the cost of new cars.

Automakers consider a huge number of factors when determining how much to charge for a new vehicle. These include the cost of building it, which incorporates raw materials, plant overhead, and labour; its list of options; the currency exchange if the vehicle is imported from another country; and how much the competitors are charging for similar vehicles.

Along with all of those, the manufacturers look at the used-car market. They monitor it by looking at how many cars were sold in the past, and the average price at which today’s used cars are selling.

While a used car can be any age, three- or four-year-old models are usually among the most common. That’s the point where many vehicles come off leases, or owners are making their final payments, but they’re still new enough to appeal to a large number of buyers.

The cost of used cars is largely determined by supply and demand. If there’s a glut of pre-owned vehicles, prices will soften. But four-year-old cars are in short supply right now, and correspondingly more expensive, because new-car sales crashed following the economic downturns in 2008. According to Scotiabank’s Global Auto Report, only some 350,000 vehicles were leased or went into fleet service in 2009/2010 — cars and trucks that normally go into the used-vehicle market as soon as their leases are up — which is less than half the numbers seen a decade before.

Right now, only about 6.5 per cent of all vehicles in Canada are four years old. As a result of the shortage, used cars are relatively expensive right now, which puts pressure on automakers trying to sell new cars.

Here’s why. If a used vehicle is pricey, and not that far away from what a new car will cost, many buyers will spend the extra money to get the new one, especially since it offers a full warranty. If automakers minimize the difference, by lowering the MSRP or by offering incentives, they’re likely to sell more new cars.

According to Scotiabank, the shortage of used cars caused by the economic crash, and the resulting higher prices of those that do come on the secondary market, have resulted in new-car prices that are currently below those of 2007.

You also might be surprised to know that our used-car market isn’t just domestic. Canada normally imports between 150,000 and 200,000 used vehicles every year from the United States, which also helps to maintain the secondary market. But the U.S. economy crashed even harder than ours did, and imports have dropped an average of 40 per cent compared to the previous five years.

There’s a final twist to all of this, too: the market is one big circle. The price of used cars goes up, so the price of new cars comes down. Those lower new-car prices put pressure on used cars, and sellers have to mark them down to get them off the lots. Any time you see big incentives on new cars, the stuff on the pre-owned lot will likely be dropping, as well.

Canadians are on track to purchase approximately 1.73 million new vehicles in 2013, a considerable step up from the 1.46 million that were sold in the tight economy of 2009. And you better believe that the automakers will have their eyes on that when it’s time to sell the new models that are yet to come.